The Bank of Japan’s latest move is a tightening of monetary policy

I don’t know if you saw the blurb on the Bank of Japan’s policy changes recently. But I thought I would point it out because it has gone mostly unremarked.

Japan’s new long-term rate corridor

Here’s how Reuters is covering it:

The Bank of Japan may allow long-term interest rates to creep up to around 0.4 percent under new guidance introduced last month, which lays the groundwork for “stealth” rate hikes, the central bank’s former executive Hideo Hayakawa said on Thursday.

The BOJ kept its yield targets steady last month but said it will allow long-term rates to move more flexibly around its zero percent target, a nod to criticism its heavy buying was shrinking bond market liquidity.

BOJ Governor Haruhiko Kuroda said long-term rates would now be allowed to move at double the range previously permitted. While market players interpreted the remark as a sign the BOJ will tolerate a rise in 10-year bond yields to around 0.2 percent, they remain unsure over how much yields would be allowed to rise beyond that.

This is effectively policy tightening, folks.

Central banks targeting long rates

Now, let’s remember, in conventional monetary policy a central bank announces its intention to sell excess reserves at a specific rate. And the market moves to that rate because of the central bank’s monopoly supply of additional reserves or a floor on interbank lending set by the central bank offering interest on excess reserves.

But, the central bank has an unlimited supply of reserves with which it can buy any asset. And so central banks have always been able to target equities as the Swiss National Bank has done, or  long-term interest rates as the Bank of Japan has done.

How to interpret the BOJ’s move

So what the Bank of Japan is telling us now is that it is increasing its target 10-year JGB yield. Yes, it is couched in terms of liquidity concerns and giving a band around the official zero target. But, this is a maneuver that has caused JGB 10-year yields to rise. So it’s a tightening of policy.

Moreover, in April, the Bank of Japan ditched its inflation target date. It had been setting a date for when it thought inflation would hit two percent. And it moved this target six times as inflation failed to take off in Japan. The last target was for March 2020. Now it has abandoned the target altogether.

So, in combination with the 10-year rate band, what the BoJ is telling you is this: we no longer care if inflation goes to 2%. The economy is doing well enough that we can allow long-term interest rates to rise.

Conclusion: the Japanese are cautiously tightening monetary policy.